(Recasts, adds comments, background)

By Stefano Rebaudo

May 8 (Reuters) - Euro zone government bond yields edged

a touch higher on Thursday, roughly unchanged after the Bank of

England after cut rates and suggested it needed to adjust policy

gradually.

UK gilt yields rose, with the policy-rate sensitive 2-year

up 7 basis points (bps) at 3.88% as some investors

had bet the BoE would signal more quick rate cuts.

"Heightened trade policy uncertainty poses the risk of

stagflation," Vivek Paul, UK chief investment strategist at

BlackRock Investment Institute.

"News today of a U.S.-UK trade deal underscores our view

that U.S. tariffs are likely to have a limited direct impact on

UK gross domestic product," he added.

U.S. President Donald Trump is expected to announce a trade

deal between the U.S. and Britain on Thursday, the New York

Times reported on Wednesday.

Some analysts recently argued the BoE could end up more

hawkish than expected as hard economic data shows no signs of a

deteriorating outlook and the impact of tariffs will be small

since the UK has limited exposure to U.S. goods demand.

Euro area borrowing costs were tracking U.S. Treasuries

after the U.S. Federal Reserve warned on Wednesday about the

risks of higher inflation and unemployment.

The Fed held interest rates steady on Wednesday but said

those risks clouded the U.S. economic outlook as policymakers

grapple with the impact of President Donald Trump's tariffs.

Germany's 10-year yield, the euro area's

benchmark, rose 2.5 bps to 2.50%. It hit 2.556% on Tuesday, its

highest level since April 14.

"While the Fed sees increased risks to both employment and

inflation, this assessment is probably obvious given the tariff

backdrop," said Hauke Siemssen, rate strategist at Commerzbank.

"More insightful were (Fed chair Jerome) Powell's remarks

that there is no real cost to waiting as the labour market is

still doing well while inflation has come down," he added,

arguing that markets did not interpret this as overly hawkish.

U.S. Treasury yields rose, with the 10-year up

3.5 bps at 4.31% after dropping the day before.

Money markets priced in a European Central Bank deposit

facility rate at 1.6% after falling to below 1.55% in mid-April

as the ECB suggested it was ready to cut rates in response to

the potential adverse impact of U.S. tariffs.

German 2-year yields, more sensitive to European

Central Bank policy rates, rose 3.0 bps to 1.75%.

Italy's 10-year yield was up 2.0 bps at 3.58%

, leaving the spread between it and Germany's Bund

yield - a market gauge of the risk premium investors demand to

hold Italian debt - at 105 bps.